The time has come to set up a federal longevity insurance administration.
It would provide support for insurance companies now lacking in the annuity market.
The FLIA would provide protection to insurance companies, encouraging them to offer the kinds of annuities that would appeal to retirement plan participants.
No matter the success of retirement readiness efforts, few plan participants or new retirees are prepared to manage their assets from defined contribution or defined benefit plans in retirement. Few of them buy an annuity to provide a steady retirement income. They prefer to manage their assets themselves.
But when participants leave the workforce with the lump sum they have built up, and seek to manage the assets themselves, they are faced with three serious risks:
- investment risk;
- inflation risk; and
- longevity risk.
They would benefit from an alternative not now available, a deferred inflation-indexed annuity.
The trouble is insurance companies don't market deferred indexed annuities. They avoid them because they would face the unpredictable risks of extraordinary increases in either inflation or longevity. Insurance companies could not afford those risks.
But the federal government could.
Our proposal would eliminate these risks without the government providing the funding: the establishment of the FLIA would enable insurance companies to provide cost-effective annuities.
Why don't American retirees choose to buy an annuity to gain the same security as from a defined benefit plan? There are multiple reasons, but many retirees believe they can gain higher annual income if they invest their money themselves.
Under our proposal, participants would purchase a deferred inflation-indexed annuity when they retire, say, at age 65, and they would begin receiving payments from it if they live to a much older age, say, 90. The premium for an annuity deferred 25 years into the future would require only a small portion of a retiree's retirement assets — perhaps as little as 3%.
Our government could enable insurance companies to offer both regular and deferred indexed annuities at relatively low premiums. Late each year, the FLIA would take bids from qualified insurance companies to fund all of the following year's indexed annuities. The accepted bids would establish which companies would offer annuities and would also establish annuity pricing, the same for everyone. The avoidance of marketing costs, plus the economies of scale, would make the pricing of annuities far more attractive.
To help minimize the cost of annuities, the FLIA would sell reinsurance to the insurance companies. It would provide both longevity and inflation protection, and the insurance companies would pay the FLIA actuarially premiums each year. The FLIA would then make annual payments to the insurance companies for increases in the consumer price index and in a longevity index. For example, if inflation exceeded 1% per year, or if the longevity of 65-year-olds increased by more than one year per decade, the FLIA would pay the insurance companies an amount equal to the increase in the companies' benefit payments above the benchmark stipulated by the policy. This support would relieve the insurance companies of worst-case risks.
In providing this protection, the FLIA would be backed by the federal government. But the premiums that insurance companies would pay for this protection should be such that the FLIA would have a 50/50 probability of at least breaking even on this protection. Earnings would flow back to the FLIA. But in the event of extreme increases in inflation or longevity, the FLIA — and hence taxpayers — would be at risk.
To get participants thinking in terms of an annuity throughout their working career, a central accounting agency would prepare each participant's annual retirement fund account report, including:
- the annual amount of an indexed annuity that the worker's existing retirement fund balance could currently buy at age 67; and
- the cost at age 67 of a deferred indexed annuity for that amount, effective at age 90.
A participant would then know how much more he or she needs to save in order to ensure an adequate income in retirement. This report would also get participants thinking about buying an annuity whenever they retire.
When retirees request their first withdrawal from their defined contribution retirement fund, the request would be used to purchase a deferred indexed annuity for them unless the retirees elected in writing any of the following options:
- buy an immediate indexed annuity;
- buy a deferred annuity starting at a different age, say 85 or 95; or
- buy no annuity.
The winners: retirees who would financially have a worry-free retirement with an annuity.
Russell “Rusty” Olson, an independent consultant on institutional investing based in Rochester, N.Y., was from 1983 to 2000 director of pension investments, worldwide, for Eastman Kodak Co. Mr. Olson is the author of four books on institutional fiduciary investing, including “The School of Hard Knocks: The Evolution of Pension Investing at Eastman Kodak.” Douglas Phillips, senior vice president, institutional resources, University of Rochester, has served for the past 14 years as chief investment officer for its $2 billion endowment fund. Mr. Phillips serves on the university's retirement committee, which is responsible for $3 billion. Mr. Phillips is a member of the investment advisory committee to the $178.32 billion New York State Common Retirement Fund, Albany. This commentary is based on their proposal for a new retirement program, detailed at Pionline.com/Olson-Phillips-Proposal.